Exam 15th Ch 5

Question 1

Direct Tax

Answer 1

will refer to any levy that is both imposed and collected on a specific group of people or organizations. (personal income tax, corporate tax, wealth taxes, property taxes)

Question 2

Indirect taxes

Answer 2

are collected from someone or some organization other than the person
or entity that would normally be responsible for the taxes (consumption taxes and specific taxes and contributions)

Question 3

Arguments in favor of personal income taxes

Answer 3

equity: a good approximation of the individual ability to pay, progressive system is
easier to impose

redistribution: possible to redistribute resources (progressive rates, deductions,
etc.)

collection: easy to measure, can be taxed at the point of transaction

Question 4

Arguments against:

Answer 4

efficiency: impact on labor supply and savings decision

Question 5

Personal income tax has three dimensions

Answer 5

taxable unit (whom are we taxing)

tax base (what do we mean by income)

tax rates (Which tax rates do we apply)

Question 6

Definition of comprehensive economic income (Ii) from Haig-Simons

Answer 6

Ii = Ci + ∆Wi

consumption (Ci): goods and services purchased, salaries in kind, use of durable
goods,…

wealth variation (∆Wi): savings, capital gains,…

Question 7

Realized Capital Gains

Answer 7

are those gains that a person has received by selling an asset

Question 8

unrealized capital gains

Answer 8

gains a person has not yet received by selling an asset but exist on paper

Question 9

Implication of Haig Simons

Answer 9

∆Wi > 0

can include unrealized gains if the market price goes up compared to what they bought it as as Haig Simons measures wealth

Question 10

Problems with Haig Simons in practice

Answer 10

▶ needs a mechanism to measure increments in the value of all capital assets held
by individuals

▶ gains would have to be adjusted for inflation to determine the real increases in
consumption capabilities

▶ difficult for goods which are not traded frequently such as antiques, jewelry, and
livestock, and homes

Question 11

In-Kind Income

Answer 11

all income should be treated equally whether cash or in-kind (subsidized medical insurance, job gives you free gym/parking)

Question 12

Merits of Haig-Simons definition

Answer 12

fairness:
▶ horizontal equity
▶ tax base includes all sources of income (but utility is not taken into account)

efficiency:
▶ neutrality: the pattern of economic activity is not distorted (but does not necessarly
minimize the excess burden)

Question 13

Dual Tax System

Answer 13

dual income tax combines a progressive tax schedule of labor with a low flat tax rate on capital and corporate income (different tax rates for different labor income and capital income)

Question 14

Global Tax System

Answer 14

all incomes are incorporated in the same tax base, being subject to the same tax rates

Question 15

When finding taxable income . . . .

Answer 15

Add all income even if it was withheld and include realized capital gains, (not unrealized capital gains, unless definitions is under Haig Simons of course)

Question 16

Tax Credit

Answer 16

a tax credit is a tax incentive which allows certain taxpayers to subtract the
amount of the credit from the total tax due

Question 17

Tax exemption

Answer 17

tax exemption refers to a monetary exemption which reduces taxable income, i.e.
some income with is not subject to the tax

Question 18

Tax deductions

Answer 18

a tax deduction is a reduction of income that is able to be taxed, and is commonly
a result of expenses, particularly those incurred to produce additional income

Question 19

Difference between deductions, exemptions and credit

Answer 19

deductions and exemptions
both reduce taxable income (and therefore indirectly tax liabilities) (taxable income-deductions & exemptions)

while credits
reduce directly tax liabilities (gross tax payable income - credit)

Question 20

When solving someones the point where someones utility (y,l) with the constraint T= leisure time + Working time

Answer 20

Maximize the utility u(y,l) subject to y = (1-τ)wl + R

Question 21

Define the uncompensated (Marshallian) labor supply function

Answer 21

w(∂u/∂y) + ∂u/∂l = 0
l(u) (w,R)

Question 22

uncompensated elasticity of labor supply

Answer 22

% change in hours when net wage w increases by 1%

e(u)= (w/l)(∂l(u)/∂w)

Question 23

income effect parameter

Answer 23

increase in earnings if person receives 1 Euro extra in non-labor income

η = w(∂l/∂R) ≤ 0

Question 24

Compensated elasticity of labor supply

Answer 24

the percentage change in the quantity supplied of labour divided by the percentage
change in the wage after subtracting the income effect of the wage change

ε(u)= ( w/l) ·(∂l(c)/∂w) > 0

Question 25

slutsky equation

Answer 25

∂l/∂w = ∂l(c)/∂w + l∂l/∂R ⇒ ε(u) = ε(c) + η

Question 26

Income Effect on Personal Income tax: Labor supply

Answer 26

Less disposable income, if the individual wants to maintain consumption level,
hours of work have to increase [positive impact on labor supply]

Question 27

Substitution Effect on Personal Income tax: Labor supply

Answer 27

leisure time becomes less expensive relative to working time [negative impact on labor supply]

Question 28

what does Feldstein elasticity of taxable income ETI measure?

Answer 28

ETI measures the taxpayers responsiveness to a tax. It is the responsiveness of a taxable income to a 1% change in the “net of tax” rate (1 − τ)

Question 29

How do you calculate ETI?

Answer 29

η = (∆y/y) / (∆(1−τ))/(1−τ)

Question 30

Consumption without taxes

Answer 30

C=Y
(consumption=earnings)

Question 31

Consumption with Taxes

Answer 31

c = y − T(y ) (consumption = earnings - net taxes)

Question 32

LAFFER CURVE 48/63

Answer 32

laffer curve is a function of tax rate and tax revenue, it is acquired by maximizing the tax revenue with respect to t (the tax) and equal it to zero

Question 33

What does it mean when subsitution effect is greater than income effect in the laffer curve?

Answer 33

individuals will work less as leisure becomes less expensive, labor supply decreases (tprime < t)

Question 34

What does it mean when income effect is greater than the substitution effect on the laffer curve?

Answer 34

Labor force will not decrease, people will work more to have the same level of income so tax revenue will increase (tprime > t)

Question 35

saving taxation, how do income and substitution effect change saving patterns?

Answer 35

Savings may
rise or fall depending on relative size
of income and substitution effect

substitution effect: Lower after-tax interest rates cause first-period consumption
to rise, reducing savings.

income effect: Lower after-tax interest rates reduce the lifetime value of income,
reducing first-period consumption and increasing savings.

Question 36

What is the optimal income tax?

Answer 36

optimal income tax equates the ratio of marginal utility per unit of
revenues across agents

The ratio of marginal utility to marginal revenue rises as tax rates rise for any taxpayer, but this ratio for Mr. Rich is everywhere below the ratio for Ms. Poor. Optimal income tax rates are those that equate this ratio across taxpayers. Here, the optimal rates are 10% for Ms. Poor and 20% for Mr. Rich.

Question 37

What is the formula for tax revenue?

Answer 37

TR = t * y(1-t)

TR = taxes collected from each person (will have a t in there) * labor supply curve

Question 38

Retained earnings

Answer 38

if corporations were not taxed on their earnings, then owners could avoid taxes by
retaining earnings.

▶ these retained earnings would earn interest tax free, effectively subsidizing savings.

▶ if corporations paid out those earnings many years later, the present discounted
value of the tax burden would be quite low.

Question 39

What is fiscal benefit

Answer 39

is is the tax base, the net profit of a business

revenue - fiscally deductible expenses

Question 40

Does economic benefit and fiscal benefit equal one another?

Answer 40

No!

Question 41

What is depreciation?

Answer 41

fixed assets suffer from depreciation, this can be amortized (spread over multiple periods)

Question 42

what is economic depreciation?

Answer 42

the real loss of value of a good

Question 43

what is fiscal depreciation

Answer 43

amortization allowed by the accountancy/fiscal law, it is what you are allowed to deduct from the initial cost, all the way ranging to 100% of the cost.

Question 44

How do you calculate the fiscal advantage?

Answer 44

FIND THE QUOTA which will be different depending on the type of depreciation

MULTIPLY THE QUOTA BY THE CORPORATE TAX RATE

Divide this above by (1+r)^1 repeat until you reach the amortization period so if amortization period is 3 years,
quota x corporate tax rate / (1+r)^1
+
quota x corporate tax rate / (1+r)^2

+

quota x corporate tax rate / (1+r)^3

(corporate tax rate X quota) / (1+r)^ amorization period

Question 45

what is the cost of unit per capital?

Answer 45

cost of capital = (r+δ) /
(1 − Θ)(1 − t)

r is the after tax rate of return

δ is the depreciation rate,

Θ is the corporate tax rate

t is the individual tax rate.

Question 46

what is the cost of capital when there is a tax credit?

Answer 46

cost of capital = (r+δ) x (1- present value of depreciation allowance - tax credit) /
(1 − Θ)(1 − t)

Question 47

When do companies invest in new technology?

Answer 47

when the cost of capital is lower than the rate of return